By: Dan Shomper

Today is one of those unofficial holidays where financial folks get a chuckle over the date matching up with a financial topic. On the list of date puns it falls after Pi day (3/14) and Star Wars day (May the 4th [be with you]), but before 401(k) day, which is celebrated the Friday after Labor Day (though trying to overtake April Fools’ Day on 4/01 feels like a missed opportunity, to me).

And indeed, 529 plans are worth celebrating.

The benefits of using a 529 plan for college savings are numerous:

  • Investment growth is tax-deferred
  • Distributions are completely tax-free when used for qualified education expenses
  • Ability to use 529 dollars for K-12 private schooling and trade schools
  • Ability to transfer accounts to a family member of the beneficiary
  • State tax deductions if contributions are made to the state-sponsored savings plan where the account owner lives (varies by state; up to $4k/beneficiary in OH)
  • No annual contribution limit for the account owners. However, 529 contributions are considered gifts for non-parent contributors. Additional planning can be done here to maximize the gift given while minimizing gift tax implications.
  • Family and friends can contribute directly to an existing 529 plan. Recent changes to the FAFSA form have streamlined this. Starting in 2024, grandparent-owned accounts are no longer included in the financial aid calculation, removing the need to plan around timing of withdrawals and having multiple accounts for one beneficiary.

We recently drafted a financial plan for a couple with four young kids. College planning is important to them, and they decided to take the conservative route: plan to fully cover private college costs for each child. The result: a whopping $2,000,000* of projected spending on college alone.

Luckily, 529 plans are purposely made for these situations. Like most investments, the longer that dollars can compound, the less contributions are needed to reach the end goal. In this example, if starting to save ten years ahead of their first college semester, about $45,000 per child would need to be saved annually. If saving begins on their first birthday, that per child number drops to about $20,000 annually. Plus, if one child obtains a full scholarship, their balance can be transferred to a sibling to offset some of the savings needed.

However, to quote an old colleague of mine, for every “gimme” there’s a “gotcha”. If dollars aren’t used for qualifying expenses like tuition and textbooks, a 10% penalty, plus taxes on all of the growth, is pinned on withdrawals. When combined with the uncertainty that the child may never need the money due to scholarships or not attending a qualified school, some savers are understandably concerned about overfunding, and we also caution clients to be careful about overfunding 529 accounts. Fortunately, legislation has recently been enacted to address the overfunding risk:

  • Effective 1/1/2024, 529 plan dollars can be used to make Roth IRA contributions for the account beneficiary. Up to $35,000 can be “contributed” from the 529 to the Roth IRA over the beneficiary’s lifetime, though still limited to the regular IRA contribution limits of $7,000 per year (in 2024; subject to future limit increases)
  • The IRS set several rules that must be followed to complete this. It’s worth reading the legislation here (section 126), but the highest hurdles are that the account must be open for at least 15 years, and contributions made within the last 5 years are not eligible.
  • If the beneficiary receives a scholarship, penalty-free withdrawals can be made up to that amount
  • Up to $10,000 of 529 dollars can be applied to student loans in the beneficiary’s name

Finally, there is one more reason that 529 plans are worth celebrating – they are incredibly easy to establish, fund, and make qualified withdrawals. Here in Ohio, the College Advantage site allows you to complete the entire process online in about 30 minutes. You can “set it and forget it” by establishing recurring contributions. When it’s time for withdrawals, most colleges appear on the College Advantage search list, so you can send payments directly to the institution. Investment selection is also straightforward. Most states offer a lineup of low-cost target date or indexed funds.

Saving for college is one of the top goals we hear from clients. It can be daunting, but it doesn’t have to be. We’re happy to help with finding the right savings amount, selecting a tax-advantaged plan, navigating withdrawals, or anything else that you have questions about.

*Projected cost of a private university currently charging $75,000 annual tuition and $10,000 room and board fees, carried 10 years forward, at an assumed inflation rate of 4%.